Converting Existing Businesses to Worker Cooperatives

Dec 5th, 2013

An interview with Melissa Hoover, Executive Director of the US Federation of Worker Cooperatives

Posted by:

John Duda

Melissa Hoover is the Executive Director of the United States Federation of Worker Cooperatives (USFWC), the national membership organization for worker cooperatives, founded in 2004. She is also a founding director of the nonprofit Democracy at Work Institute, which provides technical assistance resources to worker cooperatives. In light of the tremendous opportunity for expanded worker ownership created by retiring boomer business owners (highlighted in the NYT by our co-founder Gar Alperovitz), we asked Melissa to share her thoughts on how existing businesses can be converted to worker cooperatives.

Democracy Collaborative: Can you talk a little bit about converting existing businesses to worker cooperatives, and why it's potentially so important as the co-op movement works toward getting to scale?

Melissa Hoover: I am excited about conversions! These are existing businesses where the owner(s) sells the business to the employees, who then structure and run it as a worker cooperative. Conversions can take many different forms, and they’re sometimes called “buyouts” or “business transitions.”

Conversions are potentially so important for several reasons. Most broadly, there is a tremendous potential with such a large number of “baby boomer” business owners retiring in the coming years and decades. What will they do with their businesses? With conversions we have a huge opportunity to save businesses and jobs that might otherwise be lost if the retiring owner closes the doors or sells the business. We see conversions in all sectors, industries and regions—but we see more and more of them in places where the business is a real pillar of the community, either because it employs people in good jobs or because it provides a critical product or service, or both. So we have a whole system of existing small, locally-owned businesses that provide jobs, anchor capital, in some cases anchor downtown businesses in rural areas or whole neighborhoods in cities, and are part of the economic and social fabric of a place—and we should be spending a lot of energy and thought around how to preserve these. And if they are preserved as worker cooperatives, the benefit of that business is amplified for all its owners, and it’s much more likely to stay in that community than to move to the next cheapest place to do business.

From a cooperative development standpoint, it’s generally just a lot easier and less risky to finance the sale of an existing business than to start something from scratch. These are going concerns, with a track record, customers, suppliers, relationships, employees. They exist, and in converting to a cooperative you’re just taking an existing asset and sharing ownership and control of it. The barriers can be a lot lower than for a startup. Of course, conversions are not without their challenges, but you’re starting from somewhere.

And if I can speak tactically for a minute about growing the worker cooperative community as a movement, I see conversions as critical because they’re a chance to implement cooperatives not as some exotic boutique form of business which a lot of people seem to think they are now, but as simply another option for selling owners—and often the best option, considering that most business owners don’t want to see their businesses sold off for parts or moved to another part of the country or the world. As a practical solution to a real need, but one that’s still rooted in principles, conversions can really expand worker ownership to all kinds of new industries and areas. And one thing I’ve noticed about conversions is that those worker-owners tend to be some of the most passionate advocates for connecting to a movement and building it. So it’s really a win on several fronts.

Democracy Collaborative: There are millions of workers in the United States who own part of their company through an Employee Stock Ownership Plan; many of these have been conversions of business that were not formerly employee owned. When, in your opinion, does a conversion to a worker cooperative make more sense than going the ESOP route?

Melissa Hoover: From a practical perspective, size is a factor: an ESOP is typically impractical (too expensive and complex to set up and maintain) for smaller businesses—I think under about 40 workers or so—because there are significant legal and accounting fees and ongoing valuations and trust structures that you have to set up.

From a deeper perspective, a worker cooperative makes sense if the owners and prospective owners want to build cooperative principles into the fiber of the business, which a cooperative does (and an ESOP could do but doesn’t necessarily have to). I see people drawn to worker cooperatives over ESOPs because democratic control and participation are important enough to them to codify, and because they really embrace the member and community benefit principles of cooperatives, and want to identify themselves as a cooperative entity, with all the history and cooperative connections that attend to that form.

That said, I think we can learn a lot from our friends in the ESOP world, about participatory management and governance at a larger scale, about dedicating resources to developing an ownership culture, and about really building enough political and economic power to move legislation and influence the tax code. The ESOP world has also created an enviable infrastructure of support professionals and legislative advocacy that make ESOP conversions standard enough that there are nearly 11,000 of them in the country.

Democracy Collaborative: The success of ESOPs is in large part due to the availability of significant tax benefits for owners who decide to sell their companies to their employees. As far as we understand, those benefits are also available for conversions to worker cooperatives. Can you explain how these benefits work?

Melissa Hoover: I can try—with the caveat that to my knowledge this has only ever been done once, by Select Machine working with the Ohio Employee Ownership Center, so we’re far from well-versed in it. Basically, I’ll quote from that Select Machine case study:

“In 1984, changes in the tax law….created the “1042 rollover” which permits owners of closely held businesses who sell 30% or more of the stock in their company to their employees through an Employee Stock Ownership Plan (ESOP) or a co-operative [MH: these three words are huge!] to shelter the capital gains from taxes by rolling the proceeds of the sale over into other qualified domestic securities within 12 months of the sale.”

What this means is that in an ESOP, the owner sells the company over time, and there’s a trust mechanism that makes this standard practice. Worker cooperatives hadn’t been using this advantage, because they hadn’t figured out a way to stage the transaction over several years, and we don’t have other layers like a trust. Typically a worker cooperative is pretty straightforward: 100% member-owned from day one. The problem is that such a transaction was very hard to finance, especially if the owners were leaving and taking all that management experience with them.

So our challenge in actually using the 1042 rollover is to figure out how to set up the transaction so that ownership, and maybe governance, transitions in stages and not all at once. This is not only possible and ethical, I think it’s a critical next step to being able to facilitate the transfer of wealth (which is really what conversion is, among other things) from single owners to shared ownership at a scale that makes an impact. Another challenge is that for most selling owners contemplating a conversion, the considerable legal expense and complexity of the 1042 transaction wasn’t worth it for the size of the business or the sale. This is another solvable problem! We need to make the tools more standard and educate lawyers and accountants about them AND seek out and support conversions that are large enough to make it worth the hassle.

Democracy Collaborative: What are some of the major difficulties to overcome in converting existing businesses to worker cooperatives? And are there situations where you would advise workers to avoid conversion to a cooperative?

Melissa Hoover: Right now the major difficulty is that we don’t have the experience and tools to make the process of conversion more standard, easily understood, and well-supported. Each process in unique and idiosyncratic, and it takes a lot of time and study on everyone’s part. A related challenge is that not enough attorneys and accountants know about worker cooperatives to effectively support the process. And financing entities have no idea what to do with them yet, and have been hesitant to finance 100% buyouts.

Once we get past the general difficulties, like lack of technical assistance and financing, there are difficulties are on a case by case basis: selling owners have their own needs, buying owners have their needs, and it can be quite tricky to make sure those align. And actually, even before they align, there’s a lot of education to be done to make sure everyone understands what’s happening enough to make that judgment about alignment. The buying owners need to have a strong culture of trust and participation, and some understanding of the business, which is not always the case. And even when there is a strong culture of trust, it can still be challenging to understand and implement effective cooperative governance, participatory management, shared decision-making. We just don’t learn those things in school and don’t practice them through most parts of our adult life.

Finally, the process of conversion itself is currently pretty daunting! It can be difficult to see the stages and just put one foot in front of the other to get to the final goal. Many small business are not used to the process of education for ownership, building consensus, negotiating who has power over what, figuring out how to make decisions—it can be very foreign for a lot of groups, so you have to lay good groundwork and this can take awhile.

And yes, there are actually quite a few cases in which I would not recommend a conversion to cooperative. First, and most important, I think a conversion is generally not a way to save a failing or struggling business. I recommend conversions for healthy, viable businesses that have the surplus and stability to undertake what will be an intensive and time-consuming process. One of the things we can see in the last wave of conversions—in the 1980s—was that worker buyouts were attempting to save businesses and sometimes whole industries and sectors, and this is a lot for one business form to bear. And in the worst cases some really failing businesses were just dumped on the workers as an exit strategy, so I’d avoid that. But I should be clear that when I say “healthy, viable business,” I don’t just mean high-margin cash-rich businesses. In fact many of the first stage conversions we are seeing are stable businesses but have a relatively low profit margin—but they provide a critical service and better jobs.

I also think conversions require a relatively engaged core group of prospective worker-owners; it doesn’t have to be every last person who works in a business, but there needs to be a critical mass and a culture of engagement to be successful. And it’s better if the selling owner(s) can stick around for a little while to facilitate the leadership transition. Finally, I generally don’t think conversions are a good rapid-response strategy for dealing with a crisis or, for instance, a contract negotiation. But as soon as I say all that, I’m struck by a few strong counterexamples—the Argentinian recovered factories movement, for instance, was all about responding to crisis and reviving struggling businesses among people who didn’t necessarily know what a cooperative was when they started. So I suppose there are no absolutes—I am speaking to the preferred conditions.

Democracy Collaborative: What kind of infrastructure—legal and technical advice, financing, etc.—do you see as necessary to help facilitate more worker cooperative conversions? Is anyone working on these pieces of the puzzle at the moment?

Melissa Hoover: We definitely need more lawyers and accountants who understand worker cooperatives and really see them as a viable option for a selling owner. We’re working with the Ohio Employee Ownership Center to convene these support professionals and talk about what they need, what they agree about, where they see the challenges, and how we train more of them. And I’m not sure about financing: I think we actually don’t know enough yet to say whether finding financing for the sale is a barrier or not. What’s clear is that most workers don’t have resources to completely buy out a business in cash, so there has to be some outside financing entity or a staged buyout; in the past, lots of conversions have relied on the selling owner to finance the deal, but we’re seeing some creative options popping up, like the Direct Public Offering, where the community basically invests to finance the sale. Jenny Kassan at Cutting Edge Capital has developed a pretty powerful DPO package for conversions—I know Real Pickles used it to great success in their conversion. And I actually think conversions, with the appropriate support, are potentially very strong borrowers from the cooperative loan funds and more traditional sources of credit.

But actually, I think models of existing cooperatives and especially conversions may be the most critical tool we have to really help people understand the possibility experientially. An infrastructure to standardize and share these is the next step. This year, the Democracy at Work Institute (DAWI) is really focused on conversions, and we’re working with several partners to develop practical tools to support conversions—valuation and financing tools, governance trainings for new owners, models and curricula for businesses that are converting. We’re also developing tools for cooperative developer to most effectively play the role of a guide or coach, helping people see the roadmap and timeline, assess their needs and strengths, understand their options, and keep the process moving forward at the right pace. Finally, we’re working with a couple different state coop development centers to develop materials for economic development officials—we’re doing some research with the University of Iowa using NETS data to assess market entry and exit over the last 20 years and working with some folks in Montana to gather case studies and develop basic educational materials to try to move the conversation forward to more systemic support for conversions.

Other groups are also starting to address these needs. The Ohio Employee Ownership Center and Vermont Employee Ownership Center have both been around for awhile, and are both working on worker cooperative conversions and working with us to develop support materials. The Valley Alliance of Worker Cooperatives in Western Massachusetts has some great coop-to-coop tools. And I believe the Steelworkers have identified conversions as one of their focus areas, so I would imagine they have great union coop tools.

Democracy Collaborative: How do we raise the profile of the worker cooperative conversion option, especially to retiring business owners and their employees who may have no idea this model exists?

Melissa Hoover: I think we have to work on several fronts. At a minimum, we have to work with economic development people and small business support agencies to get basic information out there; we’re not going to raise the profile alone, and they’re in a position to really have an impact. And from a strategic perspective, we need to break down the notion of “retiring business owners” into its component parts. And I think we need to start close to home: industries we know work well with worker cooperatives, where we have some existing models, where we may have contacts at trade groups, where the barriers may be lower. To my thinking, there are strong possibilities in local foods: production, manufacturing and distribution; care industries like home care, nursing, direct care; education; green building; alternative energy. But these are just my instincts—we are doing research over the next two years to really assess the possibilities, needs, capital requirements, etc for various industries and sectors.

From the demand side, where I see a ton of interest right now—in fact most of the inquiries and projects we’re working on—is from social mission business owners who want to share ownership. These are typically people doing something they care about and running a business with the goal of improving the world in some way: green builders, alternative energy businesses, schools, caregivers, local food production. These are business owners who see sharing ownership as a natural extension of the principles that drew them to develop a business. In some cases, they’re not even retiring! They may be serial entrepreneurs who started a business but never envisioned staying at it forever, and are not looking for a big payout when they leave. In other cases, they’re people who started a business out of their passion for its work or mission, and as it grew, realized that they didn’t want to be the only owner and sell it to their workers but stay on as a worker-owner. This is a surprisingly common phenomenon.

So that’s a place to start, and starting with social mission businesses gives us some clear targets for outreach and education, some defined industries and sectors to develop tools for, and aligned groups who may be willing to pilot these approaches and tools with us. But if we want to take this to scale, I developing our capacity to support conversions in stages. Once we’ve done enough “close to home” conversions and have some data, some case studies, some champions, the next stage is thinking about the potential for scale. We have to return to why we want to support conversions (to anchor businesses, build wealth, grow a cooperative movement, and ultimately to transform the economy to better serve human beings) and see where we can go that will do that. I think manufacturing is a critical sector for conversions, and we know it can work because we see it in Mondragon, for example, but we need to really understand the process better and have some foundation in order to tackle that effectively. I also wonder about the public sector, and public-private partnerships that look something like a worker coop to deliver services—the coops in Emilia Romagna do this, and in other parts of the world too (Europe, Japan).

I think scale really is the challenge, and I don’t think there’s one right answer or approach. Reaching scale is not just about the size of enterprises but the number of them, and how effectively they are united, so we can and should be working at lots of levels—directly with selling owners where we achieve scale not at the enterprise level but because there are thousands of small conversions, but also on large-scale enterprises in manufacturing and the public sector. It’s an ecosystem.

Democracy Collaborative: In addition to the tax benefits discussed above, are there specific policies—at the local, state, or federal level—that you feel would be particularly helpful in making coop conversion more common?

Melissa Hoover: We are just starting this work and thinking about policy, so I don’t have a whole lot of insight here yet. I will say that whatever we do, we need to start with the goal of making conversion to cooperative an equally attractive option for retiring business owners as an ESOP is. We should be incentivizing High Road strategies for economic development. There should be a tax advantage for owners selling to their workers, period. I know at the state level, several groups have started talking about replicating Italy’s Marcora law, which allows unemployed workers to use their accumulated unemployment benefits to capitalize a cooperative. To me, applying some version of this approach in a conversion context where jobs are being saved makes a lot of sense. At the city economic development level, I’d like to look at all the incentives economic developers use to draw big box stores and see how we might access some of those to support conversions of existing businesses; of course we’ll need political power to do this, which is another reason to take a staged approach and really build our base and our champions as we think about policy that will support scale.

Democracy Collaborative:And to wrap up, are there specific examples of worker coop conversions that have happened recently, or that are currently underway, that you are particularly excited by?

Melissa Hoover: There is just tons of activity right now! The USFWC and DAWI have several pilot projects: three different educational and care facilities on both coasts and the Midwest, a solar installation company, an organic produce distributor, a building firm. I know the Cooperative Development Institute is working on a statewide project to support conversions there, and the Vermont and Ohio centers both have live projects. As I said earlier I see some trends. Building firms are a clear trend—I think I can count 5 completed, including Build With Prospect in New York City, and 2 in progress that were inspired by John Abrams and the South Mountain Company. That’s the power of a strong advocate focused on an industry. And I’d say local foods are also ripe for conversion. The Real Pickles buyout set a strong precedent, and we just held a webinar about cooperatives in the local food system that had over 300 people signed up for it, many of them sole proprietors looking to grow their businesses through conversion to a cooperative.

As we think about the ecosystem of conversions, I hope we will support a balance between enterprises that provide stability in a community and good jobs for vulnerable workers, like care facilities and schools, and enterprises that provide more mobility and build assets, like higher-margin manufacturing enterprises. I think both of these are a form of community wealth, and want to make sure we keep both firmly in our sights.